Source: Chicago Tribune – Detroit to stop paying some debt, putting it in default
Detroit said on Friday it would stop making payments on some of its about $18.5 billion debt, which would put it in default, and the “insolvent” city called on most of its creditors to accept pennies on the dollar to help it avoid the largest municipal bankruptcy filing in U.S. history.
In a forceful opening salvo of negotiations with debt holders, Detroit Emergency Manager Kevyn Orr announced a moratorium on some principal and interest payments, including one payment he said was due on Friday.
Under his proposal, Orr said unsecured debt holders would be paid less than 10 cents on the dollar, but some creditors would get a bit more based on city revenue. Some $11.5 billion of the debt is unsecured and $7 billion secured, according to figures presented by Orr.
Orr said secured creditors would get better treatment, although how much better was not specified. “We may try to get a discount from them, but the reality is they are secured,” Orr said. Secured credit means an asset is pledged to back the debt.
For example, Detroit has secured its interest rate swap agreements with casino revenue. He said the city would skip a $34 million payment due on Friday on $1.43 billion of pension certificates of participation, to allow the city to conserve cash needed to provide services to residents.
Fitch Ratings and Standard and Poor’s Ratings Services immediately downgraded Detroit’s rating to a level reserved for borrowers about to default. “We expect default to be a virtual certainty,” S&P said in a statement accompanying its downgrade to CC from CCC-negative. A trustee for the bond issue will have to certify that Detroit failed to make the payment on Friday, which would trigger a formal default.
Detroit’s crisis is being closely watched by U.S. debt markets. It did not immediately affect the $3.7 trillion U.S. municipal bond market, where prices ended higher on Friday.
Orr said he would meet with creditors over the next 30 days. Market participants said the outcome of those talks could lead to higher interest rates for the state of Michigan and even the broader market if Orr wins concessions from secured creditors.
“Financial mismanagement, a shrinking population, a dwindling tax base and other factors over the past 45 years have brought Detroit to the brink of financial and operational ruin,” Orr said in a statement.
Orr said the city was “insolvent,” unable to pay its debts and needed shared sacrifices from everyone, including debt holders, to have any hope of a revival. Insolvency and inability to pay debts are two tests a government must meet for a judge to accept a Chapter 9 municipal bankruptcy.
“It looks and feels like a pre-packaged bankruptcy plan,” said Richard Ciccarone, managing director at McDonnell Investment Management, in reaction to the proposal.
A pre-packaged bankruptcy is when an entity negotiates a deal with creditors and other interested parties in advance and presents that to a bankruptcy court judge.
Orr, a bankruptcy attorney brought in by the state of Michigan to clean up the city’s finances, repeated after the meeting that he sees a 50/50 chance of a bankruptcy filing.
It would be a first for a major U.S. city as New York, Philadelphia and Cleveland all avoided formal bankruptcy filings during their financial difficulties.